Type-2 rivalry can be explained by taking the coffee store example from Briefing 50 forward in time to a point where all potential customers have been captured; that is, when the market is mature.The two stores have charged the same expected price of $2.95 for a typical product and each has half of the market’s total of 5 000 customers.

Halfway through the year, the two stores make the same decisions as before: we lower our price to $2.80 and our competitor raises its price to $3.15. Figure 1 shows the impact on customers’ choice to switch stores. There is a small immediate jump in our sales, as the visit frequency and average spend per customer increase, though this is not sufficient to increase our profits because of the lower price on each purchase. However, at the same time, customers start to switch from the competitor’s store to our own at the rate of nearly 100 per week. Our customer base grows whilst our competitor’s falls, leading to a continued rise in our weekly sales and profits and a fall in theirs.

A key assumption in this customer switching is that a constant fraction of the competitor’s customer base switches each week; that is, some will tolerate the competitor’s higher price for a longer time than others. Indeed, the scenario shown implies that customers are very patient — 26 weeks after the price changes, less than half of the rival’s customers have switched to our store, in spite of a $0.35 cheaper typical price. If, however, customers concerned about price were to switch immediately, but the fraction of customers concerned varied with the size of the price gap, then there would be a pulse of “customers switching to our store per week,” rather than the continuing flow shown in the center of figure 1. The pulse would be small for a narrow price differential, and large for a greater one.

Until next time…

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New entrants in type-2 rivalry

One factor that keeps firms from pushing hard to win customers in mature industries where type-2 rivalry is strong arises from the risk of escalating retaliation. Cellphone firms in mature markets, for example, are careful not to initiate price-wars that would simply destroy their own profitability along with that of their rivals. This is of less concern for a new entrant, who has no current business to lose. The airline industry offers examples of this: SouthWest, Ryanair, and their low-cost rivals have easily stolen customers from established airlines with a value-proposition that the incumbents cannot match. Even if they could do so, incumbents’ reluctance is understandable, since they would simply be giving away margin and cannibalizing their own business.This briefing summarises material from chapter 7 of Strategic Management Dynamics, pages 436-438.
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